Are tax effects important in the long-run fisher relationship? Evidence from the municipal bond market

Are nominal bonds appropriately discounted for taxes? Empirical estimates o f the response of nominal interest rates to changes in inflation, the Fishe r effect, have failed to produce a definitive answer. Four reasons have bee n put forward as possible explanations: (i) Tobin effects, (ii) fiscal illu sion, (iii) peso problems, and (iv) different estimators. Utilizing data on taxable and tax-exempt bond interest rates and several different estimator s, we find that the Fisher effect estimates are always larger for the taxab le bond relative to the tax-exempt bond, suggesting that fiscal illusion an d different estimators cannot account for the previous results.